In an economic downturn, VCTs offer investors a range of advantages
By Jack Rose, Triple Point – With the economic uncertainty prompted by Covid-19 likely to continue into the foreseeable future, one of the few certainties is that companies need to have a high-quality product or service, be adaptable, well capitalised and led by an outstanding management team. In doing so, they will ensure they are better placed to deal with the ongoing and varied challenges of the economic crisis as well as offering investors value in a turbulent market.
For investors, these metrics point to young, tech-oriented companies with a clear purpose, which will be vital as we look to ‘build back better’ and emerge from the worst of the pandemic. Many such companies are unlisted, but investors can gain exposure to these young and potentially ground-breaking companies through VCTs, which also offer tax advantages in an environment where high public expenditure is likely to come at the cost of tax increases.
VCTs remain appealing despite wider market volatility
Covid-19 has shocked the global economy, on a scale that surpasses the 2007-2009 financial crisis. However, times of great economic upheaval often lead to the formation of dynamic and innovative companies. For example, in the last crisis, a number of disruptive start-ups were able to scale-up and succeed such as Uber, Slack and Venmo. They, among others, enjoyed fast-paced growth and have established themselves as leading businesses, with many achieving ‘unicorn’ status.
Today’s economic conditions offer similar opportunities for well-placed start-ups. Indeed, from a value perspective, in the context of potentially overvalued and frothy mega cap stocks, nimbler early-stage businesses are more appropriately valued to reflect the current situation and therefore offer better value as their potential is realised.
These businesses are also able to accelerate their growth and boost their value as a result of cheaper resources and easier access to talent – both effects of a stalling economy. For example, office rents have begun a rare decline, and in many cities, they are forecast to continue to fall by as much as 40 per cent over the next 18 months. Weaker labour markets enable start-ups to have readier access to a pool of skilled talent, which would, in less difficult times, be to a greater extent the preserve of larger businesses. In addition, cheaper marketing costs enable growth businesses to enhance their ability to target a greater number of potential clients.
Addressing risks for promising start-ups
For early stage companies, there are clearly a number of very real obstacles on the journey from start-up to scale-up. From a screening perspective, it is absolutely essential that an investment manager seeks to understand and address the most significant risks facing promising young companies.
Traditional venture investing typically focuses on researching a broad cohort of companies to identify those businesses that are likely to be successful. However, this analysis often does not take enough account of market fit and whether there is a demand for the product or service, a critical reason often cited when start-ups fail. When we delve into the research, it indicates that the number one reason for start-up failure, impacting over 40 per cent of cases researched, is a lack of proven demand for a product or service.
Triple Point’s distinct ‘challenge led approach’ aims to actively address this risk by typically investing in companies that have already established a demand for their products or services by working alongside larger, blue chip companies or having them as clients. This approach validates not only the early-stage company’s business model, but also provides some stability and credibility needed for a start-up to mature into an established firm. As a seasoned VCT manager with an extensive range of corporate relationships, Triple Point is well-placed to identify promising businesses. The firm has managed over GBP260 million worth of VCT and EIS company exits to date.
With taxes tipped to rise demand for VCTs will likely increase
One of the main features of 2020 has been the unprecedented increase in public spending as central banks and governments attempt to mitigate the economic fallout caused by the pandemic. UK government debt has already risen above GBP2 trillion as a result of measures to support the economy.
While tax rises have been ruled out this year, they are likely to be considered next year as the Government looks to reduce this debt mountain. However, there are a number of investment schemes that are less likely to be targeted by potential reforms due to being specifically designed to boost investment into early stage UK businesses in return for providing investors with generous tax breaks. These include the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) propositions.
VCTs offer hard-pressed investors one route to manage their exposure to tax rises, as VCTs offer tax relief and tax-free dividends, while also putting investors’ money to work backing growth companies to help them play as strong a role as they can in accelerating our economic recovery.